Euro break-up: Let Germany lead the northern core and France the rest

The respected economist and Telegraph columnist summarises the argument for an
orderly break-up of the eurozone if a struggling member was forced to leave
that won him the Wolfson Economics prize.

Bootle's break-up suggestion: A northern monetary union centred on Germany, and including Austria, the Netherlands and Luxembourg, and perhaps Finland and Belgium, with a French-led bloc of former eurozone nations.Photo: Alamy

By now it is widely recognised that some form of euro break-up is on the cards. Yet what form? It may be that only one country leaves, with the rest continuing as now. But this prospect seems unlikely to me. Although Greece is an extreme case, Portugal, Italy, Ireland and Spain are all shaky.

Alternatively, there could be a complete break-up, with all current member states returning to national currencies. This also seems unlikely, not least because there is still a strong desire in key countries to preserve the single currency idea.

The optimal reconfiguration would probably involve the retention of a northern monetary union centred on Germany, and including Austria, the Netherlands and Luxembourg, and perhaps Finland and Belgium. These countries are pretty well aligned with Germany, economically, institutionally and culturally. If their electorates so desired, it would be perfectly plausible for these countries to form a full fiscal and political union.

The most intriguing issue concerns France. It has been Germany's close partner, and the two economies have tended to move together. However, France's recent performance has in some ways resembled the peripheral economies. It has a current account deficit as opposed to Germany's surplus and its primary budget deficit is close to Greece's. It also has strong banking and financial links to the peripheral economies. Moreover, although it is not as uncompetitive as the peripheral countries, France has also lost competitiveness against Germany.

Given these points, I would advise France to stay out of a northern monetary union. Indeed, there would be attractions for it in leading a grouping of former euro members. This would split the eurozone into two roughly equal parts, with the French-led bloc slightly larger.

Yet this would amount to a complete overturning of post-war French economic and political strategy. I suspect that the French establishment would choose to stick with Germany without even thinking about it. If so, as the new, German-dominated currency rose on the exchanges, France could end up paying a very heavy price – just as it did in the 1930s when it decided to stay on the Gold Standard long after Britain left.

There is an important issue, though, about the process through which a reconfiguration came about. The euro could be reduced to a northern core through the southern countries leaving. But alternatively this could happen through the departure of the core countries. This would mean that the stronger economies, rather than the weaker southern ones, would bear the costs of leaving the currency union. More importantly, there would be less need for debtors in the weaker economies to default as they could continue to service euro liabilities in euros as their home currency.

Which of these two processes was followed would make a big difference to how the euro performed on the exchanges. For if the weak countries left, the euro would be the currency of the strong northern core. It would surely rise on the foreign exchanges. By contrast, if the strong countries left, to forge their own, new currency, the euro would be the currency of the weaker southern countries. It would surely fall on the exchanges. The uncertainty as to which of these might happen is one reason why the existing euro has not been weaker on the exchanges.

In fact, whichever countries decided to stay together in a northern monetary union, it is not obvious that the peripheral economies should remain together in a southern union. We tend to lump them together under the unflattering acronym PIIGS, but in fact they are all very different, and they have only limited levels of trade with each other. They would be better off being able to set their own domestic policies and allowing their exchange rates to float.

Moreover, however attractive a German exit might be, it looks unlikely. Germany and other core countries are not (yet) prepared to make this leap. So, in practice, if the euro is to be reconfigured, it looks as though it will be through the departure of the weaker southern members, one by one. In that case, we would end up with a set of independent floating currencies for the peripheral countries while the euro continued as the currency of the German-dominated northern core. In my view, this cannot happen soon enough – both for their sakes and for ours.

• A special version of Roger Bootle's recent book, "The Trouble with Markets", incorporating a new chapter on the euro crisis based on the prize-winning Wolfson essay, is available now in Kindle and other ebook formats (ISBN 9781857889888), published by Nicholas Brealey. Hard copies will be available in the shops shortly.